AEB 3103 Principles of Food and Resource Economics

Module 2: Supply and Demand

Who determines gasoline price?

Components of a market

Competitive market:

For now let’s focus on perfectly competitive market

(Really, a talking lion)

Conditions of competitive markets

  1. There are lots of buyers and sellers
  1. Good and/or service are identical
  2. Free entry & exit
  3. Perfect information about prices & goods

Think about the following market

Definition of demand

The law of demand

What happens when the price of something goes up? \(P\uparrow -> Q_d \downarrow\) \(P\downarrow -> Q_d \uparrow\)

The law of demand

The law of demand

As the price of a good increase, the quantity demanded of that good decreases.

(Demand curves are downward sloping.)

Some other concepts:

Some more math/graph about the demand curve

Suppose we have a demand curve: P = 100 - 2Q. What does that even mean?

Shifting the demand curve

Let’s say we have a demand curve for hotels here in Gainesville, FL. What shifts its demand?

Five factors that shift the demand curve:

Example

Example: Suppose you’re a chef, and you can serve steak or chicken interchangeably in your recipes. Due to some unforeseen issues associated with the supply chain of cattle, the price of beef increases dramatically.

  1. Are chicken and beef substitutes or complements?

  2. What happens to the demand curve for margarine?

  3. What happens to the demand curve for beef?

2. Changes in income

3. Change in taste and preferences

Tastes and preferences are subjective and vary across individuals

4. Change in expectations

If you expect prices to change in the future, it may affect your demand today.

Example: Should you buy a house today if you expect interest rates to rise by 3% next year?

5. Changes in the number of consumers

More consumers increases demand.

Aggregating market demand

Aggregate demand: horizontal sum of all individual demand curves in the market

In-class exercise #2:

Suppose we’re interested in the market for hamburgers. What happens to demand for hamburgers in the following scenarios:

Supply

Represents the behavior of sellers

The law of supply: As the price of a good increases, the quantity supplied of that good increases, ceteris paribus

Graphing supply curves

Shifting the supply curve

Let’s say we have a supply curve for hotels here in Gainesville, FL. What shifts its supply?

Five factors that shift the supply curve

  1. Change in input prices
  2. Change in prices of related goods
  3. Change in technology
  4. Change in expectations
  5. Change in the number of suppliers

Changes in input prices

Decrease input price -> profit increase -> encourages more supply

Increase input price -> profit decrease -> discourages supply

Example: When chip price increases, computer and phone prices increase

Changes in technology

Innovation lowers costs and increases supply

Changes in Expectations

Prices expected to increase -> Supply goes down

(Under one condition: the producer can actually stock the product without depreciation)

Changes in the number of producers

Aggregated supply curve

Market Equilibrium

Solving for market equilibrium

Suppose we have:

What is the equilibrium price, P*, and equilibrium quantity consumed and produced, Q*?

What happens when the market does not clear?

Price Gouging

After hurricane Charley:

The price gouging statue

Florida Statute 501.160 states that during a state of emergency, it is unlawful to rent, sell, lease, offer to rent, sell, or lease essential commodities, dwelling units, or self-storage facilities at an unconscionable price. A price is presumed to be unconscionable if: (1) there is a gross disparity between the price charged during the state of emergency and the average price during the 30 days before the state of emergency or (2) the price grossly exceeds the average price the same or similar commodity was available in the trade area during the 30 days before the declaration of the state of emergency, unless the seller can justify the price by showing increases in its costs or market trends. Examples of necessary commodities for storm events are food, water, ice, gas, lodging and lumber.

Michael Sandel, moral philosopher at Harvard:

“This is not the normal free market situation where willing buyers freely elect to enter into the marketplace and meet willing sellers, where a price is agreed upon based on supply and demand. In an emergency, buyers under duress have no freedom. Their purchases of necessities like safe lodging are forced.”

“If you look closely at the price-gouging debate, you’ll notice that the arguments for and against price-gouging laws revolve around three ideas: maximizing welfare, respecting freedom, and promoting virtue…” (And none of these three ideas stand.)

Milton Friedman: “Gougers deserve a medal.”

You are a resident of Fort Myers, FL. NWS says that Hurricane Ian will make landfall within the next 36 hours. You expect that the hurricane will cause your home to be cut off from water and electricity for days, and you currently do not have enough supply for water, battery, and gas stocked.

There are two local stores in your town. Aabadaba has a huge line in front of the store with other folks eager to buy essential items. Your estimate is that you are not going to get those essentials when it is your turn. They are charging their regular price. Babadaba has water, battery, and gas available for purchase right away, but the price is 50% higher than what they normally sell these goods.

  1. Which store would you turn to?
  2. How does the supply and demand curve shifts from normal in this case, and what does that imply about the equilibrium?
  3. How do you think about the behavior of the two stores?

You are the owner of a local store in Fort Myers, FL. NWS says that Hurricane Ian will make landfall within the next 36 hours. You have only limited inventory items for water, battery, and gas. There is a huge line in front of your store with folks urging for those essential items.

A local wholesale company will make one last shipment to your store tomorrow, but they are charging 40% higher price than usual. Your gross margin is only 20% - so if you restock inventory and sell at the regular price, you will lose money.

You have the following options. Which one should you choose, and why?

  1. Sell inventory at normal price, and do not restock until after the hurricane
  2. Restock and sell at 50% higher price than usual
  3. Restock and sell at normal price, which incurs at least a 20% loss for every item you sell

Moving into new equilibrium

What happens to the market equilibrium when supply or demand shifts?

Consumers in Gainesville consider houses and apartments to be substitutes. There is an increase in the price of houses in Gainesville at the same time three new apartment buildings open there. In the market for apartments in Gainesville:

(This is one of the ambiguous problems from the textbook)

  1. the equilibrium price will rise.
  2. the equilibrium price will fall.
  3. the equilibrium quantity will rise.
  4. the equilibrium quantity will fall.

What happens to the equilibrium price and quantity if following a social media campaign, more people want to play Minecraft?

How does COVID impacts the equilibrium price and quantity of beef?